Topic 8-Adjusting Process

TOPIC 8
The Adjusting Process

Study
Study Objectives
Objectives
1. Explain the time period assumption.
2. Explain the accrual basis of accounting.
3. Explain the reasons for adjusting entries.
4. Identify the major types of adjusting entries.
5. Prepare adjusting entries for deferrals.
6. Prepare adjusting entries for accruals.
7. Describe the nature and purpose of an adjusted
trial balance.
Current
Current Liabilities
Liabilities and
and Contingencies
Contingencies
The
The Adjusted
Adjusted
The
The Basics
Basics of
of Trial
Trial Balance
Balance and
and
Timing
Timing Issues
Issues Adjusting
Adjusting Financial
Financial
Entries
Entries Statements
Statements
Time period Types of Preparing the

assumption adjusting entries adjusted trial
Fiscal and Adjusting entries balance
calendar years for deferrals Preparing
Accrual- vs. cash- Adjusting entries financial
basis accounting for accruals statements
Recognizing Summary of
revenues and journalizing and
expenses posting
Timing
Timing Issues
Issues
Accountants divide the economic life of a
business into artificial time periods
(Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.
Generally a month, a quarter, or a year.

Fiscal year vs. calendar year
Also known as the “Periodicity Assumption”
LO 1 Explain the time period assumption.
Timing
Timing Issues
Issues
Review
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which it is earned.
b. expenses should be matched with revenues.
c. the economic life of a business can be divided
into artificial time periods.
d. the fiscal year should correspond with the
calendar year.
LO 1 Explain the time period assumption.

Timing
Timing Issues
Issues
Accrual- vs. Cash-Basis Accounting
Accrual-Basis Accounting
Transactions recorded in the periods in which
the events occur
Revenues are recognized when earned, rather
than when cash is received.
Expenses are recognized when incurred, rather
than when paid.
LO 2 Explain the accrual basis of accounting.

Timing
Timing Issues
Issues
Accrual- vs. Cash-Basis Accounting
Cash-Basis Accounting
Revenues are recognized when cash is received.
Expenses are recognized when cash is paid.
Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).

Timing
Timing Issues
Issues
Recognizing Revenues and Expenses
Revenue Recognition Principle
Companies recognize
revenue in the accounting
period in which it is
earned.
In a service enterprise,
revenue is considered to
be earned at the time the
service is performed.

Timing
Timing Issues
Issues
Recognizing Revenues and Expenses
Matching Principle
Match expenses with
revenues in the period
when the company makes
efforts to generate
those revenues.
“Let the expenses follow

the revenues.”

Timing
Timing Issues
Issues
GAAP relationships
in revenue and
expense recognition
Illustration 3-1

Timing
Timing Issues
Issues
Review
One of the following statements about the accrual basis
of accounting is false. That statement is:
a. Events that change a company’s financial
statements are recorded in the periods in which
the events occur.
b. Revenue is recognized in the period in which it is
earned.
c. This basis is in accord with generally accepted
accounting principles.
d. Revenue is recorded only when cash is received, and
expense is recorded only when cash is paid.
The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries
Adjusting entries make it possible to report
correct amounts on the balance sheet and
on the income statement.
A company must make adjusting entries

every time it prepares financial statements.
LO 3 Explain the reasons for adjusting entries.

The
The Basics
Basics of
of Adjusting
Adjusting Entries
Entries
Revenues - recorded in the period in which
they are earned.
earned
Expenses - recognized in the period in which
they are incurred.
incurred
Adjusting entries - needed to ensure that
the revenue recognition and matching
principles are followed.

Timing
Timing Issues
Issues
Review
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which
they are incurred.
b. revenues are recorded in the period in which
they are earned.
c. balance sheet and income statement accounts
have correct balances at the end of an
accounting period.
d. all of the above.

Types
Types of
of Adjusting
Adjusting Entries
Entries
Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash and Revenues earned but not
recorded as assets before yet received in cash or
they are used or consumed. recorded.
2. Unearned Revenues. 4. Accrued Expenses.

Revenues received in cash Expenses incurred but not
and recorded as liabilities yet paid in cash or
before they are earned. recorded.
LO 4 Identify the major types of adjusting entries.

Trial
Trial Balance
Balance
Trial Balance – Each account is analyzed to determine
whether it is complete and up-to-date.
Phoenix Consulting - Jan. 31st (before adjusting entries)

Acct. No. Account Debit Credit
100 Cash $ 50,000
105 Accounts receivable 35,000
110 Prepaid insurance 12,000
120 Equipment 24,000
130 Investments 300,000
200 Accounts payable $ 20,000
210 Unearned revenue 24,000
220 Note payable 200,000
300 Austin, capital 40,000
400 Sales 137,000
$ 421,000 $ 421,000
LO 4 Identify the major types of adjusting entries.

Adjusting
Adjusting Entries
Entries for
for Deferrals
Deferrals
Deferrals are either:
Prepaid expenses or
Unearned revenues.
LO 5 Prepare adjusting entries for deferrals.

Adjusting
Adjusting Entries
Entries for
for “Prepaid
“Prepaid Expenses”
Expenses”
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

insurance rent
supplies maintenance on equipment
advertising fixed assets (depreciation)

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Prepaid Expenses
Costs that expire either with the passage of time
or through use.
Adjusting entries (1) to record the expenses that

apply to the current accounting period, and (2) to
show the unexpired costs in the asset accounts.

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Illustration 3-4
Adjusting entries for prepaid expenses
Increases (debits) an expense account and

Decreases (credits) an asset account.

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Example (Insurance): On Jan. 1st, Phoenix Consulting
paid $12,000 for 12 months of insurance coverage. Show
the journal entry to record the payment on Jan. 1st.
Jan. 1 Prepaid insurance 12,000

Cash 12,000
Prepaid Insurance Cash

Debit Credit Debit Credit
12,000 12,000

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Example (Insurance): On Jan. 1st, Phoenix Consulting
paid $12,000 for 12 months of insurance coverage. Show
the adjusting journal entry required at Jan. 31st.
Jan. 31 Insurance expense 1,000

Prepaid insurance 1,000
Prepaid Insurance Insurance expense

12,000 1,000 1,000
11,000

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Depreciation
Buildings, equipment, and vehicles (long-lived
assets) are recorded as assets, rather than an
expense, in the year acquired.
Companies report a portion of the cost of a long-
lived asset as an expense (depreciation) during
each period of the asset’s useful life (Matching
Principle).

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Example (Depreciation): On Jan. 1st, Phoenix
Consulting paid $24,000 for equipment that has an
estimated useful life of 20 years. Show the journal entry
to record the purchase of the equipment on Jan. 1st.
Jan. 1 Equipment 24,000
Cash 24,000
Equipment Cash
24,000 24,000

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Example (Depreciation): On Jan. 1st, Phoenix Consulting
paid $24,000 for equipment that has an estimated useful life
of 20 years. Show the adjusting journal entry required at
Jan. 31st. ($24,000 / 20 yrs. / 12 months = $100)
Jan. 31 Depreciation expense 100

Accumulated depreciation 100
Depreciation expense Accumulated depreciation

100 100
100

Adjusting
Adjusting Entries
Entries for
for “Prepaid
Expenses”
Depreciation (Statement Presentation)

Accumulated Depreciation—is a contra asset
account.
Appears just after the account it offsets
(Equipment) on the balance sheet.
Balance Sheet Jan. 31

Assets
Equipment 24,000
Accumulated Depreciation (100)
Net Equipment 23,900

Adjusting
Adjusting Entries
Entries for
for “Unearned
“Unearned Revenues”
Revenues”
Receipt of cash that is recorded as a liability because

the revenue has not been earned.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard

to:rent magazine subscriptions
airline tickets customer deposits
school tuition

Adjusting
Adjusting Entries
Entries for
for “Unearned
Revenues”
Unearned Revenues
Company makes an adjusting entry to record the
revenue that has been earned and to show the
liability that remains.
The adjusting entry for unearned revenues results

in a decrease (a debit) to a liability account and an
increase (a credit) to a revenue account.

Adjusting
Adjusting Entries
Entries for
for “Unearned
Revenues”
Illustration 3-10
Adjusting entries for unearned revenues
Decrease (a debit) to a liability account and

Increase (a credit) to a revenue account.
Adjusting
Adjusting Entries
Entries for
for “Unearned
Revenues”
Example: On Jan. 1st, Phoenix Consulting received
$24,000 from Arcadia High School for 3 months rent in
advance. Show the journal entry to record the receipt on
Jan. 1st.
Jan. 1 Cash 24,000
Unearned rent revenue 24,000
Cash Unearned Rent Revenue

24,000 24,000

Adjusting
Adjusting Entries
Entries for
for “Unearned Revenues””
“Unearned Revenues
Example: On Jan. 1st, Phoenix Consulting received
$24,000 from Arcadia High School for 3 months rent in
advance. Show the adjusting journal entry required on Jan.
31st.
Jan. 31 Unearned rent revenue 8,000
Rent revenue 8,000
Rent Revenue Unearned Rent Revenue

8,000 8,000 24,000
16,000

Adjusting
Adjusting Entries
Entries for
for Accruals
Accruals
Made to record:
Revenues earned and
Expenses incurred
in the current accounting period that have not

been recognized through daily entries.
LO 6 Prepare adjusting entries for accruals.

Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Revenues”
Revenues”
Revenues earned but not yet received in cash or
recorded.
Adjusting entry results in:
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard

to:rent
interest
services performed

Adjusting
Adjusting Entries
Entries for
for “Accrued
Revenues”
Accrued Revenues
An adjusting entry serves two purposes:
(1) It shows the receivable that exists, and
(2) It records the revenues earned.

Adjusting
Adjusting Entries
Entries for
for “Accrued
Revenues”
Illustration 3-13
Adjusting entries for accrued revenues
Increases (debits) an asset account and

Increases (credits) a revenue account.
Adjusting
Adjusting Entries
Entries for
for “Accrued
Revenues”
Example: On Jan. 1st, Phoenix Consulting invested
$300,000 in securities that return 5% interest per year.
Show the journal entry to record the investment on Jan. 1st.
Jan. 1 Investments 300,00

Cash 0 300,000
Investments Cash
300,000 300,000

Adjusting
Adjusting Entries
Entries for
for “Accrued
Revenues”
Example: On Jan. 1st, Phoenix Consulting invested

$300,000 in securities that return 5% interest per year.
Show the adjusting journal entry required on Jan. 31st.
($300,000 x 5% / 12 months = $1,250)
Jan. 31 Interest receivable 1,250
Interest revenue 1,250
Interest Receivable Interest Revenue

1,250 1,250

Adjusting
Adjusting Entries
Entries for
for “Accrued
“Accrued Expenses”
Expenses”
Expenses incurred but not yet paid in cash or
recorded.
Adjusting entry results in:
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard

to:rent taxes
interest salaries

Adjusting
Adjusting Entries
Entries for
for “Accrued
Expenses”
Accrued Expenses
(1) It records the obligations, and
(2) It recognizes the expenses.

Adjusting
Adjusting Entries
Entries for
for “Accrued
Expenses”
Illustration 3-16
Adjusting entries for accrued expenses
Increases (debits) an expense account and

Increases (credits) a liability account.
Adjusting
Adjusting Entries
Entries for
for “Accrued
Expenses”
Example: On Jan. 2nd, Phoenix Consulting borrowed
$200,000 at a rate of 9% per year. Interest is due on first
of each month. Show the journal entry to record the
borrowing on Jan. 2nd.
Jan. 2 Cash 200,00
Notes payable 0 200,000
Cash Notes Payable

200,000 200,000

Adjusting
Adjusting Entries
Entries for
for “Accrued
Expenses”
Example: On Jan. 2nd, Phoenix Consulting borrowed

$200,000 at a rate of 9% per year. Interest is due on first
of each month. Show the adjusting journal entry required on
Jan. 31st. ($200,000 x 9% / 12 months = $1,500)
Jan. 31 Interest expense 1,500
Interest payable 1,500
Interest Expense Interest Payable

1,500 1,500

Adjusting
Adjusting Entries
Entries for
for “Accrued
Expenses”
Accrued Expenses
(1) It records the obligations, and
(2) it recognizes the expenses.

The
The Adjusted
Adjusted Trial
Trial Balance
Balance
After all adjusting entries are journalized and
posted the company prepares another trial
balance from the ledger accounts (Adjusted Trial
Balance).
Its purpose is to prove the equality of debit

balances and credit balances in the ledger.
LO 7 Describe the nature and purpose of an adjusted trial balance.

Timing
Timing Issues
Issues
Review
Which of the following statements is incorrect
concerning the adjusted trial balance?
a. An adjusted trial balance proves the equality of the
total debit balances and the total credit balances in
the ledger after all adjustments are made.
b. The adjusted trial balance provides the primary
basis for the preparation of financial statements.
c. The adjusted trial balance lists the account balances
segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the
adjusting entries have been journalized and posted.
Preparing
Preparing Financial
Financial Statements
Statements
Financial
Statements are
are prepared
prepared directly
directly from
from the
the
Adjusted
Adjusted Trial
Trial Balance.
Balance.
Statement
Statement
Balance Income of
of Cash
Sheet Statement Retained
Flows
Earnings

Preparing
Preparing Financial
Statements
Adjusted Trial Balance Debit Credit
Cash $ 50,000 Income Statement
Accounts receivable 35,000
Interest receivable 1,250 Income Statement
For the Month Ended Jan. 31,
Equipment 24,000
Accumulated depreciation $ 100 Revenues:
Investments 300,000 Sales $ 137,000
Accounts payable 20,000 Interest revenue 1,250
Rent revenue 8,000
Unearned revenue 16,000
Total revenue 146,250
Note payable 200,000
Austin, capital 40,000 Expenses:
Sales 137,000 Interest expense 1,500
Interest revenue 1,250 Depreciation expense 100
Rent revenue 8,000 Insurance expense 1,000
Interest expense 1,500
Total expenses 2,600
Depreciation expense 100
Insurance expense 1,000
Net income $ 143,650
$ 423,850 $ 423,850

Preparing
Preparing Financial
Statements
Adjusted Trial Balance Debit Credit
Cash $ 50,000
Interest receivable 1,250
Equipment 24,000
Accumulated depreciation
Investments 300,000
$ 100
Statement of
Accounts payable 20,000 Owners’ Equity
Statement of Owners' Equity
For the Month Ended Jan. 31,
Austin, capital 40,000
Sales 137,000 Austin, Capital, Jan. 1 $ 40,000
Interest revenue 1,250 + Net income 143,650
Rent revenue 8,000 - Drawings 0
Interest expense 1,500 Austin, Capital, Jan. 31 $ 183,650
Depreciation expense 100
$ 423,850 $ 423,850

Preparing
Preparing Financial
Statements
Adjusted Trial Balance Debit Credit Balance Sheet Jan. 31
Cash $ 50,000 Assets
Cash $ 50,000
Interest receivable 1,250
Equipment 24,000 Interest receivable 1,250
Accumulated depreciation $ 100 Prepaid insurance 11,000
Investments 300,000 Equipment 24,000
Accounts payable 20,000 Accum. Depreciation (100)
Interest payable 1,500 Investments 300,000
Total assets $ 421,150
Liabilities & Owners' Equity
Austin, capital 40,000
Sales 137,000 Accounts payable $ 20,000
Interest revenue 1,250 Interst payable 1,500
Rent revenue 8,000 Unearned revenue 16,000
Interest expense 1,500 Note payable 200,000
Depreciation expense 100 Austin, capital 183,650
Total liab. & equity $ 421,150
$ 423,850 $ 423,850

Extended trial balances
 An extended trial balance is a worksheet
for drafting a set of financial statements.
 It is very useful when there are a lot of
adjustments to be made.
 The trial balance is extracted from the
ledgers and the adjustments are made
against this.
 The financial statements are then worked
out across the page.
An extended trial balance
End – Topic 8

Topic 8-Adjusting Process

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TOPIC 8

The Adjusting Process

Time period Types of Preparing the

Generally a month, a quarter, or a year.

LO 1 Explain the time period assumption.

LO 2 Explain the accrual basis of accounting.

LO 2 Explain the accrual basis of accounting.

LO 2 Explain the accrual basis of accounting.

“Let the expenses follow

LO 2 Explain the accrual basis of accounting.

LO 2 Explain the accrual basis of accounting.

A company must make adjusting entries

LO 3 Explain the reasons for adjusting entries.

LO 3 Explain the reasons for adjusting entries.

LO 3 Explain the reasons for adjusting entries.

2. Unearned Revenues. 4. Accrued Expenses.

LO 4 Identify the major types of adjusting entries.

Phoenix Consulting - Jan. 31st (before adjusting entries)

LO 4 Identify the major types of adjusting entries.

LO 5 Prepare adjusting entries for deferrals.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

LO 5 Prepare adjusting entries for deferrals.

Adjusting entries (1) to record the expenses that

LO 5 Prepare adjusting entries for deferrals.

Increases (debits) an expense account and

LO 5 Prepare adjusting entries for deferrals.

Jan. 1 Prepaid insurance 12,000

Prepaid Insurance Cash

LO 5 Prepare adjusting entries for deferrals.

Jan. 31 Insurance expense 1,000

Prepaid Insurance Insurance expense

LO 5 Prepare adjusting entries for deferrals.

LO 5 Prepare adjusting entries for deferrals.

LO 5 Prepare adjusting entries for deferrals.

Jan. 31 Depreciation expense 100

Depreciation expense Accumulated depreciation

LO 5 Prepare adjusting entries for deferrals.

Depreciation (Statement Presentation)

Balance Sheet Jan. 31

LO 5 Prepare adjusting entries for deferrals.

Receipt of cash that is recorded as a liability because

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard

LO 5 Prepare adjusting entries for deferrals.

The adjusting entry for unearned revenues results

LO 5 Prepare adjusting entries for deferrals.

Decrease (a debit) to a liability account and

Cash Unearned Rent Revenue

LO 5 Prepare adjusting entries for deferrals.

Rent Revenue Unearned Rent Revenue

LO 5 Prepare adjusting entries for deferrals.

in the current accounting period that have not

LO 6 Prepare adjusting entries for accruals.

Adjusting entry results in:

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard

LO 6 Prepare adjusting entries for accruals.

(1) It shows the receivable that exists, and

(2) It records the revenues earned.